In tandem with other Asian markets, India?s stock markets, too, have been gripped by uncertainty about the future. Over the past month, India?s market indices have been moving in a narrow range, with bears and bulls evenly matched, unable to take a clear view on their future course of action. Over the past few trading sessions, both the Sensex and Nifty have slowly moved up and are close to the tops they made after the Budget. However, it is still not clear, whether the indices will make a decisive move upwards to scale new peaks.
This may seem puzzling in the context of projections that India?s GDP growth may once again touch 7% this year. While India?s growth story remains intact, the market?s cautious mood is explained by uncertainties about the future pace of growth in corporate earnings. Added to that is uncertainty about the impact of oil prices on both, global and Indian economic growth, inflation and interest rates. Not surprisingly, foreign funds, which remain the main movers of our markets, have chosen to book profits during May and the rise in indices is largely due to purchases by domestic mutual funds.
When the market slips into a consolidation zone within a narrow range, as it has in the past few weeks, it waits for a trigger to make a decisive directional breakout. During May, the market has absorbed negative triggers, such as the hike in US interest rates, followed by a signal from the RBI that if inflation increases, interest rates in India too could rise in the near future.
What has helped neutralise these negative developments is the fall in the global crude oil price from around $58 to below $50 per barrel and better than expected performance of the US economy. However, if last Wednesday?s move to $51 per barrel is sustained, the indices may dip again, reflecting concerns about the negative impact on the global economy and the fear that in India too, a sharp hike in diesel prices could fuel inflation and trigger increases in interest rates.
The reason why interest rates have become a critical factor is because any increase in these could slow the pace of corporate earnings growth and also hurt new investments. Over the past two years, robust topline growth recorded by Indian companies, particularly those of the old economy, have yielded hefty bottomlines, as businesses have gained operating leverage through better capacity utilisation and falling interest costs. Operating margins are likely to come under pressure this year, as companies are operating at close to full capacity. In this context, any increase in interest costs, particularly when companies borrow to create fresh capacity, would reduce profitability. As the movement in market indices is determined more by future expectations of earnings, rather than current profitability, this is precisely what explains the cautious mood of investors, who are not as bullish about the future as they were last year.
• Stock markets are in a mood of uncertainty on inflation and interest rates • Which act as critical factors in corporates earnings growth and investment • Announcements on lower government borrowing and subsidy cuts will help |
This is evident from the dwindling investor interest in frontline stocks. The focus has now shifted to mid-cap stocks, as investors fish for new growth stories among smaller companies. As a report in this newspaper points out, the share of turnover on the BSE in B1 stocks has increased from less than 20% in April to well over 30% now. Not surprisingly, in recent weeks the NSE mid-cap index has outperformed the Nifty and has now reached an all-time high of over 3,000. There is a limit, however, to the movement of the mid-cap index, as companies with smaller equities cannot satisfy the appetite of large investors such as FIIs. Con-sequently, the level of flow of funds into the market would remain low, till large-cap companies demonstrate their capacity to sustain the momentum of high earnings? growth.
One factor that has added to the uncertainty is the difficulty faced by the ruling coalition in generating a quick consensus on the quantum of hike in domestic prices of oil. Here, the price of diesel would play a crucial role. If the price increase were kept moderate by some reduction in duties, the negative impact on the market would be limited. But should diesel prices increase by over Rs 3 a litre, market indices could show a perceptible fall, eroding the gains of recent weeks. And if, nature forbid, this is accompanied by an erratic behaviour of the monsoon, the bearish mood could last for a few months, particularly if the first quarter results of frontline companies show signs of any tapering of growth in profits.
Against this backdrop, a better than expected monsoon would be one positive trigger for the market, as it would allay fears about inflation and interest rates. It would also generate confidence about corporate performance, supported by high domestic demand and GDP growth. The second positive trigger would be a fall in the global price of crude oil to the region of $45 per barrel or lower.
Should our policy makers take note of the current mood in the market? Surely, one of the goals of policy is to sustain investor confidence and some decisive action could provide some cheer to the markets. Buoyancy in markets goes beyond stimulating inflows of foreign portfolio investments. It also stimulates investment by enhancing flows to fund growth plans of companies. To allay concerns on future increases in interest rates, the government could announce steps to reduce its borrowing programme through accelerating disinvestments in select companies, like BHEL. The same goal could be served by announcing some cuts in subsidies. It is all to the good that the PM has held Cabinet-level discussions on both these issues. In addition, steps to speed up reforms in key sectors such as banking, retail, agriculture and food processing could add some lustre to India?s growth story.
The writer is an advisor to Ficci. These are his personal views
